Baker Hughes Incorporated

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Baker Hughes Incorporated

3900 Essex Lane
Houston, Texas 77027
U.S.A.
(713) 439-8600
Fax: (713) 439-8699

Public Company
Incorporated: 1987
Employees: 20,400
Sales: $1.76 billion
Stock Exchanges: New York Pacific Zürich Basel Geneva Lausanne

Baker Hughes is the product of the 1987 merger of two oilfield-services companies with surprisingly similar histories. As the early Baker Oil Tools and Hughes Tool Company surged and retreated with their inventiveness and the vicissitudes of the global oil market, so will their modern offspring, the world’s second-largest supplier of drill bits, oil-rig components, and services that aid the world petroleum industry.

Baker and Hughes followed such similar paths that, despite their difficult combination in the late 1980s, it is not surprising that the two firms make for such a cozy modern fit. Both were founded shortly before World War I by aggressive entrepreneurs who won valuable patents and earned gushing royalties on early oil-extraction devices. Both continued as domestic powerhouses well past the turn of the century, when, at slightly different cues, they embarked on massive worldwide expansion and diversification projects. Baker and Hughes became public companies within ten years of each other as the influence of their founding families diminished. The two rivals experienced the fluctuations of an unpredictable world oil market jarred by political and economic events. Finally, the companies suffered financial slumps in the lean years of the 1980s, leading to their turbulent but successful consolidation.

There were differences, however, between Baker Oil Tools—later Baker International—and Hughes Tool. Hughes became the neglected plaything of Howard Hughes Jr., the founder’s famous billionaire son, who used the oil company’s constant wellspring of cash to finance financially successful ventures in airplanes, real estate, and motion pictures. Baker, on the other hand, built a reputation, through careful yet ambitious expansion, as one of the industry’s best-run firms, largely on the efforts of E.H. Clark, an executive whose tenure spanned 40 years.

The invention of the first rotary drill bit, used to drill oil wells through rock, led to the creation of Sharp-Hughes Tool Company in 1909. Howard Hughes Sr. and Sharp developed and manufactured the rotary drill bit, an invention so important to the fledgling oil industry of 1909 that variations of the same bit are used today. When Sharp died in 1912, Hughes bought Sharp’s share of the business. Hughes incorporated the business the following year, and in 1915 dropped Sharp’s name from the company. Armed with the exclusive patent to an essential product, Hughes brought his Houston-based company unrivaled market dominance for decades. Even after many key patents expired, during the 1930s and 1940s Hughes Tool was able to dominate the drill-bit business. During World War I Hughes developed a boring machine that could drill into enemy trenches. Explosives then could be dropped into the trenches. Although the secretary of war personally thanked Hughes for his contribution, the machine was never used because of the sudden shift, toward the end of the war, from trench warfare to active warfare.

If the market dominance of Hughes Tool was secured by the elder Howard Hughes before World War I, its tenor as an undiversified, closely held giant was set by the founder’s son and namesake. The 19-year-old Howard Hughes Jr. inherited the company in 1924 following the death of his father. Under Hughes Jr., the oil-field-product company became a massive enterprise that he used largely to fund his various avocations. During World War II Hughes operated a gun plant and a strut-making facility for aircraft, in Dickinson, Texas.

Howard Hughes, who himself founded Hughes Aircraft Company, purchased over 78% of TransWorld Airlines’s stock, and held a substantial investment in RKO Pictures, remained the sole owner of Hughes Tool until 1972, when he put the company on the market. Hughes Tool became a publicly owned company, in a transaction reportedly valued at $150 million. Although successful, despite a general slump in the drilling industry from 1958 to 1972, Hughes Tool had remained undiversified, primarily because Howard Hughes wanted it that way. “Mr. Hughes, of course, felt he was personally diversified, so he never really considered diversifying the tool company,” Raymond Holliday, a former Hughes chairman, told Business Week, October 13, 1980. With public stockholders and a booming oil economy, especially after the Organization of Petroleum Exportion Countries (OPEC) oil embargo of the early 1970s, Hughes Tool made up for lost time, bringing on worldwide acquisitions and start-up projects.

Under the leadership of Chairman James Lesch the firm purchased the Byron Jackson oil-field-equipment division of Borg-Warner in 1974, for $46 million. In 1978 Hughes bought Brown Oil Tools, another family-owned business, whose founder had under-utilized his 377 lucrative patents. With its massive expansion and the favorable oil-industry climate, Hughes Tool surged. By 1981—a peak year in the industry—new business activities, which largely meant non-drill-bit products and services, accounted for 55% of the company’s sales.

When the bottom fell out of the market in 1982, Hughes found itself a bloated, overextended, and debt-ridden concern. Under the guidance of President William Kistler, an engineer who came up through the core drill-bit division, the company retrenched to its roots, concentrating on bits and shying away from services. For example, the company shut down 30 foreign offices and streamlined 11 divisions into one. In 1983 Hughes hired outside consultants Bain & Company to trim fat, laying off 36% of its work force. The company still had one weapon neither world markets nor competitors could take away: a patented O-ring rock-bit seal. In 1986 Hughes won a $227 million patent-infringement judgement from Smith International, a California concern that had copied Hughes’s drill seal too closely. In 1985 Hughes had been awarded $122 million from Dresser Industries for patent violation. One rival that had innovated around Hughes’s patent rather than copying it was Baker International.

Hughes Tool floundered through the mid-1980s. For the three years beginning in 1983, Hughes lost $200 million. Often cited as a potential takeover target, the company was faced with an offer it could not refuse when approached for a merger with Baker.

Like Hughes Tool, Baker grew out of a single invention— the Baker Casing Shoe—a device to ensure the uninterrupted flow of oil through a well, developed in 1907 by Californian Reuben C. “Carl” Baker. Baker licensed his patents and incorporated the Baker Casing Shoe Company in 1913, mainly to protect his numerous patents on products that would soon become the industry standard. During World War I Baker was a member of the local draft board, although his company did not devote any of its production to goods to support the war effort. Baker lived off his royalties until the 1920s when he began manufacturing his own tools. In 1928, after successfully manufacturing tools in Huntington Park, California, for several years, Baker called the company Baker Oil Tools, a name it would carry for 40 years.

The Depression hit Baker hard, causing it to lay off numerous workers, but the late 1930s and 1940s were years of solid growth. During this period the company started offices in many states including Texas, Wyoming, Illinois, Missouri, and Louisiana. During World War II Baker retooled to produce gun-recoil mechanisms. Following the war Baker prospered. In the ten years after 1948 it opened 50 new offices in 16 states. In 1956 Carl Baker retired at age 85, leaving the company in the hands of Theodore Sutter, an executive who had joined the company in the early 1920s. Carl Baker died shortly after his retirement. Under Sutter the company began to expand globally, and it went public in 1961.

When E.H. “Hubie” Clark Jr. assumed control of Baker in 1965, the company developed into a global powerhouse. Clark, who had joined the company as a recent mechanical-engineering graduate from the California Institute of Technology in 1947, led Baker, now based in Orange, California, to new heights. Although Baker remained based in California, in 1965 the company’s Houston operation was as large as the California operation. Clark acquired some 20 companies, the largest of which was Reed Tool Company, a drill-bit manufacturer acquired in 1975. Clark worked hard to predict trends in oil supply and demand. Baker operations were begun in Peru, Nigeria, Libya, Iran, and Australia, among other countries, and in 1976 the company changed its name to Baker International Corporation.

The company’s reputation for quality and Clark’s renown as a manager put Baker into the 1980s in solid shape. Even Baker could not avoid the downturn of petroleum-related business after 1981. Clark and Baker President James D. Woods sought to improve efficiency in the slow-growing industry. The eventual answer was to merge with its Houston-based competitor, Hughes Tool. Both companies had been losing money and they hoped to eliminate overproduction by merging.

“This industry is plagued with overcapacity,” said one Baker official, as he announced on October 22, 1986, that the two oil-services firms would merge. Wall Street immediately applauded the move, a complex stock swap that favored Baker stockholders by giving them one share of the new company for each share they owned, compared with an eight-tenths-of-a-share deal for Hughes shareholders. Reflecting the greater general strength of Baker, its executives were to be given the top posts: Clark was to be the new chairman and Woods the new president and chief executive officer, while William A. Kistler, Hughes’s chairman, would be named the combination’s vice chairman. The new company’s home would be Houston, where Hughes was based, and where Baker already had extensive operations. Baker’s Orange, California, headquarters housed relatively few employees.

Wall Street showed its excitement over the merger by trading up the stock prices of both companies following the merger announcement, but the federal government frowned on the potential antitrust ramifications of combining two such powerful outfits. Indeed, the U.S. Justice Department announced on January 25, 1987, that it would attempt to block the merger, citing reduced competition in markets for some oil-exploration machinery. As top executives worked out a consent agreement with the Justice Department, Hughes executives attempted to pull out of the merger. Baker responded in strong terms: it would sue Hughes for $1 billion if it failed to carry through with the agreement. After several delays Hughes capitulated. On April 3, 1987, Hughes agreed to the terms of the consent decree—which included the divestiture of the domestic operations of Reed Tool Company and some other units—and the merger was completed, creating an oil-services company second in size only to Schlumberger.

The consolidated company has not stopped charging forward since its merger. Baker Hughes outpaced its competition in the late 1980s. Part of its success was in realignment: Woods slashed 6,000 jobs, closed several plants, and took a $1 billion write-off for restructuring expenses. The result was $90 million less in annual costs and impressive sales. As the company headed into the 1990s, it was set to continue a fast pace of new-business exploration through research, acquisitions, sales, and diversification—such as using technology and know-how to address environmental concerns.